Clary Hood and the Anatomy of a Credible Reasonable Compensation Opinion

Clary Hood, Inc. v. Commissioner, T.C. Memo. 2022-15, affirmed in part, vacated in part, and remanded, No. 22-1573 (4th Cir. May 31, 2023), illustrates how courts assess compensation deductions and expert evidence. The South Carolina contractor paid its CEO a $5 million bonus in each of 2015 and 2016, in addition to salary. The Tax Court partly disallowed the deductions and imposed a 2016 accuracy-related penalty. The Fourth Circuit upheld the deduction determinations but vacated the $282,398 penalty after finding that the reasonable-cause defense based on reliance on tax advisers also applied to 2016.

Read closely, the opinion is less about the dollar figures than about methodology. Both sides retained compensation experts, and the court’s treatment of them offers four lessons for any attorney or CPA preparing a compensation dispute.

1. Comparability matters within the full analysis

The Fourth Circuit applied a multifactor analysis, with compensation at comparable businesses serving as important evidence rather than the sole test. The credited analysis selected survey data for contractors with revenues and assets similar to the taxpayer and examined officer compensation as a percentage of revenue. The discounted analysis rested on what the court saw as dubious assumptions — treating a private regional contractor as comparable to publicly traded national construction firms. An expert who cannot defend the comparator set factor by factor loses the court before reaching a conclusion.

2. Catch-up compensation is a real doctrine — if it’s documented

Notably, the IRS’s own expert agreed the CEO had been undercompensated in earlier years and that some current-year “catch-up” pay was reasonable, proposing a method to separate current compensation from make-up amounts. A catch-up compensation position must substantiate both earlier undercompensation and the portion of current compensation intended to remedy it. Contemporaneous records, compensation history, board minutes, and reliable market evidence can help support that showing.

3. The witness must own the report

One of the sharper lessons: the taxpayer’s testifying economist admitted that a co-author had done most of the work and was more familiar with the report’s contents, and he was unable to supply missing comparable-salary data on cross-examination. Under Tax Court rules the expert report serves as direct testimony — so a witness who cannot defend every input is a liability, not an asset. When retaining an expert, confirm that the signing witness takes responsibility for the opinion, understands the underlying analysis and any team contributions, and can explain and defend the work in testimony.

4. The “hired gun” label is fatal — and earned

The Tax Court will likely reject opinions that appear to start from the premise that the compensation was reasonable and tailor the analysis to fit; selecting data to justify a desired result brands an expert as a hired gun. A neutral analysis that concedes unhelpful facts and still supports the taxpayer in substantial part is more persuasive than one that sides with the client on everything. Independence is not a courtesy — it is the mechanism by which the opinion acquires evidentiary weight.

What this means before your dispute reaches a courtroom

Most reasonable compensation controversies are resolved at examination or Appeals, where the same principles apply with lower stakes: documented comparability, defensible methodology, and an analyst who will stand behind the work. Engaging the expert early — ideally when compensation is set, via an opinion letter or study, or at the first examination notice for S corporation and closely held company matters — preserves options that disappear once positions harden.

Grahall’s consultants provide independent reasonable compensation analysis, reports, and testimony nationwide. For engagement mechanics and deliverables, see how counsel retain us, or request a conflicts check — party names only, nothing confidential.

This material is general educational information, not legal or tax advice for a particular matter. Requirements vary by jurisdiction and can change. Counsel and tax advisers should verify the governing rules. No tax treatment, privilege, admissibility or case outcome is guaranteed. An inquiry does not create an engagement.